EU’s Expert Advisory Group, chaired by Erkki Liikanen, reported yesterday on whether to legally separate retail from investment banking – as considered by the Vickers Commission and discussed at the weekend by Ed Miliband.
The Liikanen Report proposes five things. First, although the report suggests investment banking could be done within the same banking group as retail activities – so banks would still offer consumers a universal suite of financial services – these activities should be legally ringfenced from each other. Second, banks should have recovery and resolution plans (“living wills”). Third, banks should have bail-in-able debt. Fourth, the technical treatment of risk in imposing capital requirements should change, in particular by introducing maximum loan-to-value and/or loan-to-income ratios in respect of mortgages. Fifth, corporate governance and risk management requirements should change, including greater restrictions on the scale and forms of bank bonuses.
Much of this is familiar ground to UK observers. Furthermore, recovery and resolution plans, bail-ins, and bonuses, have already been discussed previous at European Union-level.
But four points stand out. First, the Liikanen Report states that the purpose of legally isolating investment banking from retail banking activities is to reduce the burden on taxpayers of the “explicit and implicit guarantee”. In contrast, chancellor George Osborne has stated that UK deposits carry no implicit guarantee beyond statutory deposit insurance. And, although the Vickers interim report could be interpreted as implying that retail banks would always be bailed out, the final report concluded that it would be easier to allow retail banks to go bust, so there would be less pressure for an implicit government guarantee. Perhaps this important difference reflects the fact that, in many parts of Europe (especially France, Italy and Spain), retail deposit-taking has a long history of being a nationalised or quasi-nationalised activity.
Second, the Liikanen Report states that forex and interest rate swaps and options for non-bank clients for risk management purposes would fall within the retail bank – as per the UK government’s proposals, where they notably differed from Vickers’. Third, the Liikanen Report talks of special and particular bail-in-able debt instruments. By contrast, there is a view in the UK (shared by Paul Tucker, the deputy governor of the BoE) that all bank bonds should be bail-in-able. Fourth, the UK has for 20 years allowed more-than-100 per cent mortgages, to facilitate labour mobility when there is negative equity. The Liikanen approach might forbid these.
Overall, with the Liikanen report, the EU is rapidly converging on similar thinking on banking separation to that now established in the UK, but with its own nuanced spin. But where there is a difference, if national governments will be those that bail banks out, won’t they want to set the rules that limit the risk of explicit or implicit bailout promises being called upon?
Andrew Lilico is chairman of Europe Economics.